Inventec carried out manufacturing activities in the electronics industry on behalf of its parent company. It took formal title to the raw materials, but considered that its role was limited to assembly, without assuming risk or adding value to the materials. Inventec therefore used ROVAC (return on value added costs – not including cost of materials) as a profit level indicator (PLI) in its transfer pricing analysis.
The tax authorities disagreed with the choice of PLI and considered ROTC (return on total costs – including materials) to be more appropriate.
An appeal was filed by Inventec, which ended up before the regional court.
Judgment
The regional court found that the tax authorities had failed to take into account Inventec’s FAR profile and that the alternative choice of profit level indicator – ROTC instead of ROVAC – had therefore not been sufficiently justified. On this basis, the court quashed the assessment and remitted the case to the tax authorities for reconsideration.
Excerpt in English
“37. Furthermore, the contested decision fails to take into account how the fact that the material costs of the compared companies are significantly lower than those of the applicant and the fact that the applicant has a significantly higher turnover than the companies under assessment affect the outcome of the benchmark profit figure. It is not only the risk and functional profile of the applicant, but also these facts that the Regional Court considers relevant for a fair comparison. The defendant’s claim (paragraph 113 of the contested decision) that those differences are compensated for by the fact that it produces similar products on the same market is not convincing. It is understandable that it is not always possible to have 100 % comparable companies that fully fit the applicant’s business model. However, the tax authorities are obliged to make an appropriate adjustment when they find economic differences which could affect the assessed values. In addition, the transactional profit method must be used with particular care to ensure that it does not lead to the imposition of excessive taxes on companies primarily because they realise lower than average profits or to the undertaxation of companies that realise higher than average profits. Therefore, due care should be taken to calculate the values correctly in the light of all the relevant circumstances of the case and to justify the calculations on the basis of objective criteria. The assessment of the reference price is not an exact science, but a judgment whose correctness must be reliably justified.
38. It must therefore be demonstrated whether or not it is necessary to apply a mark-up to the cost of the material to the same extent as for companies which process the material directly and change their properties. Indeed, that view is partly accepted by the tax authorities in other tax proceedings which also concern the applicant. In the result of the audit findings so far for the 2015 tax year, the tax authority has taken the view that the applicant should be remunerated at least in part by a material cost mark-up and thus perceives that the applicant performed limited risk and liability functions in relation to the material it owned in 2015. The Tax Administrator considered it clear that the profitability did not correspond to the entire unadjusted ROTC markup percentage. The tax administrator in this tax proceeding performed an analysis resulting in a quantification of the proportion of function and risk borne by the claimant in order to realise the claimant’s remuneration. The Regional Court agreed with this approach and is convinced that this approach is more consistent with the fact that the claimant’s risk and function profile does not fully match that of a contract manufacturer; on the other hand, because of the very limited liability, it does not match that of a contract manufacturer in the payroll. The Court emphasises that the model types of contract manufacturer and producer in payroll may not be an exact reflection of reality, but are merely thresholds between which market actors move, and it is therefore not overly important to have far-reaching discussions about whether the claimant is a full-fledged contract manufacturer or producer in payroll. The audit findings to date for the 2015 tax year show that the tax authorities did not consider the risk and functional profile in 2015 to be different from that in 2013 (see, for example, p. 8). The fact that the situation was similar in 2013 and in subsequent years is confirmed by the interviews of witnesses J. H. (quality supervisor) and M.A. (personnel manager), who stated that their statements concerning the applicant’s functioning also applied to 2013 (see, for example, page 7 of the witness interview report of 12 May 2022, no. 86265/22/4200-30762-711761). In the Court’s view, the defendant’s assertion that it did not include the percentage reduction in the 2013 tax year now under review in its calculation because of the plaintiff’s failure to testify, i.e., passivity, is too formalistic in a situation where the plaintiff’s employees as witnesses merely confirmed the plaintiff’s earlier assertions, and does not correspond to a fair and objective assessment of the plaintiff’s consistent assertions regarding its functions and risks throughout the tax proceedings.”
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